Financing the deleveraging of Ireland’s banks
Pre-crisis, Irish securitization was all about financing bank expansion. RMBS notes were a way for international investors to fund Ireland’s extraordinary property bubble, mediated by the bank originators that today are largely in state hands. Post-crisis, the same technology has worked in reverse. Today, securitization is largely being used to finance not the expansion of the banks, but their deleveraging, writes Owen Sanderson.
A hedge fund manager leans back in his seat in a London restaurant. “I’m thinking of buying a house in Dublin” he says. “I’m there nearly every week, and every time I fly, it’s always the same — the plane is full of private equity guys, property guys, other funds. It’s a regular commute.”
In the last year or so, Irish bank deleveraging has turned from a trickle into a torrent. PricewaterhouseCoopers’ loan portfolio advisory unit estimated in March this year that more than €26bn of Irish loan books would trade this year, with €8.5bn of commercial real estate deals and €2.5bn of corporate loans already completed, and another €16bn of portfolio sales in progress.
Big property books are trading to the top US private equity funds — Apollo, Cerberus, Kennedy Wilson, TPG, Carlyle, Blackstone — leaving smaller investors to hunt below the radar, trying to pick up bargains beneath the notice of the big players.
Assets on sale span the spectrum. A high profile bidding war erupted for some of the top trophy commercial properties in Dublin, as Kennedy Wilson and Northwood Investors fought to unwind a failed Commerzbank securitization, Opera (CMH) last year. But car parks, development loans, half built estates, mortgages performing and non-performing, are all on offer, with opportunities up and down the capital stack and in hard assets as well.
Some investment banks are joining in to. Goldman Sachs, Bank of America Merrill Lynch, and Deutsche Bank go toe-to-toe with private equity in bidding for Irish assets on their own account, as well as providing leverage against the portfolios that private equity firms do win.
Other institutions are less likely to join the bidding, but remain happy to offer loans to the funds that do. These loans, in turn, are often in securitization format, or use the skills banks have honed in their real estate origination or commercial real estate capital markets departments.
Morgan Stanley, for example, offers financing to the large funds, but not buying for its own account — this typically requires lots of extra infrastructure, such as a loan-servicing platform. Morgan Stanley decided to spin out Morgan Stanley Mortgage Servicing, selling it this year to Mount Street.
Sometimes buyers or their financiers distribute the portfolio risk, but more often, they keep it. Only a few trades, such as Deutsche Bank’s Consumer Auto Receivables Finance Limited auto deal, ever come out in rated note format.
“There is a huge demand for senior financing risk in Ireland and few difficulties syndicating risk originated in the country,” said Niall O’Rourke, head of the deleveraging and lending group in Europe at Morgan Stanley in London.
O’Rourke declined to comment on the extent to which Morgan Stanley distributes the risk of its Ireland portfolio financings.
Private equity buyers may also prefer to keep their financing on balance sheet to ease the work-out process, even if investors would like to see some higher yielding Irish assets come out in bond form.
“The assets being sold are mostly the ones with a bit of hair. There’s potential for a public ABS takeout at some point but the bank facilities give them time to manage and stabilise the portfolio,” says Pat Connors, head of European ABS Finance at Deutsche Bank in London.
As Ireland stabilises (and once big discounts for performing assets are off the table) the pattern of sales is changing. “There’s still a lot of demand from private equity and hedge funds for Irish assets, but the question is how many deals will close,” says Boudewijn Dierick, head of flow ABS and covered bond structuring at BNP Paribas in London. “Lots of the banks now have access to funding, and no need to sell assets at a big discount. These funds have high return targets, and if the haircut on a portfolio goes for example from 20% to 10%, it’s much harder to achieve that even when leverage is also cheaper.”
But as domestic banks have slowed down their sales process, the foreign banks in the Irish market have stepped up. RBS, KBC, Lloyds and Danske are still pulling back from the market and selling assets.
“I don’t think there’s going to be a slowdown in the way these trades are getting closed. Domestic banks have sold a lot of what they want to do, but foreign banks withdrawing from the market have plenty left,” says O’Rourke. “For those banks, AQR and strategic imperatives are more important. Even though they have the funding, they still want to cut their Ireland exposure.”
Though the private market is more lively and lucrative, traditional bank sponsored securitization, with public, rated notes and broad syndication, is showing green shoots.
Only one publicly sold Irish RMBS has been placed since the crisis, Permanent TSB’s Fastnet 9, but the market undoubtedly exists for more.
When Fastnet 9 was issued, last November, price was uncertain. Syndicate managers away from the deal expected it to just creep inside a 200bp margin; overwhelming demand took it down to 165bp.
The bonds are now trading around 101.4, from pricing at par. As in other markets, securitization investors in Europe have been searching for yield, moving out of their post-crisis comfort zones of UK and Dutch RMBS into peripheral assets (where they can be found).
The biggest threat to this emergent market comes not from Irish weakness, but from strength — a function of the market’s faith in the Irish sovereign.
“Irish banks have very competitive financing sources in senior and covered bonds,” says Connors. “ABS is there at a competitive level but it is only one of a number of options.”
Irish banks are now funding at levels of 80bp for five year senior unsecured (Allied Irish was the last issuer in the market in April, though even this bond is now bid over 102), and have ready access to subordinated debt as well. If they are willing to tie up collateral, covered bond funding is available below 50bp.
“Spreads now are at levels that are interesting for issuers to fund via RMBS or ABS, but it takes time to set up deals and place them,” says Dierick. “It’s true that until recently though, covered bonds have seen a lot more volume as that market opened up earlier.”
Permanent TSB, the only issuer to come to the RMBS market so far, does not have an existing covered bond programme, unlike the other large Irish banks.
In structuring its new deal, Permanent TSB had to pledge some of its best mortgages to the securitization SPV — loans which had never been delinquent, or which had exhibited such exemplary performance through the crushing Irish property bust it was hard to imagine how they could lose a cent in any realistic future.
It also added a replenishment feature to deal with “extend and pretend” mortgages. Once mortgages are three months behind on their payments, the deal records a paper loss — which can then be cured by the deal cashflows. Without such features, non-performing mortgages can simply be extended indefinitely, or the arrears can be capitalised, increasing the nominal size of the asset pool even as the asset performance deteriorates.
Doing the deal also tied up a large volume of collateral. Fastnet 9 issued €500m of ‘A1’ notes to the market, supported by €520.4m of mezzanine and subordinated notes, which it retained — an advance rate of less than 50%.
Why, then, would another bank go through this if it can get covered bonds at 52bp and senior unsecured at 80bp? Diversifying investors is one reason; regulatory treatment (securitizations offer asset and liability matched funding) is another.
Funding non-mortgage assets can be a reason, but deals may not reach the capital markets. Deutsche Bank and Bank of America Merrill Lynch arranged a €500m credit card securitization for Allied Irish Banks late last year, but AIB described it as a “two year floating rate bilateral term funding transaction”, because it remained with the two arrangers.
An easier and cheaper option than setting up a new securitization programme is remarketing a retained deal, which has been a popular option for Italian banks returning to the securitization market. These deals would have been structured to present to the ECB for repo, but can be turned into public trades in some cases.
“Ireland has a smaller retained market than some peripheral countries, as it was one of the first countries to be downgraded and RMBS needed AAA ratings at the ECB at the time,” says Dierick. “But it still might be an interesting option for some issuers which have outstanding deals with performing pools.”
Future of funding
The future of Irish securitization, like the future of most capital markets, depends on the European Central Bank. Investors have appetite to buy, issuers have access to markets and assets need funding. But the rules of the game are being changed.
At the beginning of June, the ECB came right out with what it had been hinting for months — it would look at purchasing ABS. The details of the scheme are yet to be published, but it is a safe bet that it will focus on real economy lending backed by super-clean homogeneous asset pools.
The ECB could even mean buying untranched ABS — French banks already have a scheme to funnel their SME loans into unrated, untranched, but repo-eligible securities, and the ECB is said to be looking at rolling it out in other eurozone countries — but it will certainly be disruptive to the market as it stands today.
“In general the ECB’s announcement that it would look at buying ABS was positive for the market spreads, but the TLTROs could reduce issuance given the cheap pricing. It’s to be determined at present,” says Connors.
So even after the ECB’s big reveal, there is still every reason to keep watching the central bank.
Irish securitization is pulled in two directions from Frankfurt. Banks will continue selling assets, cleaning their portfolios (and offering tempting opportunities to private equity firms) as they jostle to get ready for the asset quality review and for supervision under the ECB. But the fresh tide of cheap money could easily drown the public Irish securitization funding market after only a single issue.